The RBI last night came out with measures aimed at restoring stability to the foreign exchange market, including curbing borrowing by banks and draining Rs. 12,000 crore. That led the rupee to appreciate by 68 paise to 59.21 against the dollar in intraday trade on Tuesday.

"Apart from hurting margins through higher borrowing cost, it may impact credit growth and asset quality," said Amar Ambani, head of research at India Infoline.

"Increase in yields of long-dated government securities could spell treasury losses for some banks."

The 30-share Sensex opened lower at 19,788.09 and dropped to a low of 19,649.58. It recovered later to 19,890.63, before ending at 19,851.23, still a loss of 183.25 points, or 0.91%. The index had gained 740.36 points, or 3.84%, in the previous three days.

The 50-share Nifty index on the NSE fell 1.25% to 5,955.25, while the SX40 index on the MCX-SX closed 0.71% lower at 11,854.7.

Meanwhile, finance minister P Chidambaram on Tuesday said last night's measures by the Reserve Bank have nothing to do with the upcoming monetary policy review and may not impact interest rates of banks.

The decline in financial stocks was led by ICICI Bank, State Bank of India, HDFC and HDFC Bank. Apart from bank stocks, shares of realty, capital goods, consumer durable, metal, PSU and auto companies declined.

Telecom stocks gained as Prime Minister Manmohan Singh was scheduled to chair a meeting of senior ministers to discuss a proposal to increase limits for foreign direct investment in several sectors, including telecom.

Foreign institutional investors sold a net Rs. 357.4 crore of shares, according to the BSE website.

European stock markets were mixed ahead of data on German economic sentiment, an indicator of optimism among the country's investors. Key indices, including those in France and Germany, were down by 0.25% to 0.46%, while UK's FTSE was quoted 0.14% higher.

Most Asian stocks rose, following overnight gains in US stocks, as weaker-than-forecast US retail sales growth backed the view that the Federal Reserve will hold off reducing its bond-buying stimulus.

Benchmark indices in China, Hong Kong, Taiwan and Japan were up by 0.04% to 0.64%, while indices in South Korea and Singapore were down by 0.37% to 0.47%.